State Street Starts Seeking Less Complexity

Eleven months ago, Pacific Investment Management renewed its contract with State Street to manage its investment operations, on an outsourced basis.

That meant that, in one deal alone, State Street's outsourcing operation would look after the needs of $1.1 trillion worth of assets.

The original agreement in 2000 was one of the first outsourcing pacts in the investment management industry and the deal that really kickstarted State Street's outsourcing business.

On the back of the PIMCO deal, State Street has built a business that handles middle office functions for large firms with $8 trillion in assets.

Now, State Street is trying to expand its outsourcing business, by reaching much smaller asset managers. The target: Small- to mid-sized investment managers.

The amount of assets under management is less, to be sure. But that is not how Dick Taggart, senior vice president and head of State Street's Middle Office Outsourcing Operations, defines the investment managers that State Street now wants to serve.

Instead, he draws the line on complexity.

Where a PIMCO might be involved in a wide variety of asset classes, not just bonds, the new State Street targets may operate in just one "investment class.''

Where a PIMCO might operate nationally and internationally, the new State Street targets might operate in one or two regions of the United States, only.

Such investment management operations say, rather frequently, that they can't grow the way they'd like, without better behind-the scenes handling of transaction records, corporate action processing, reconciliation of trade details and other middle office functions.

In a recent survey of more than 160 boutique managers conducted by the Economist Intelligence Unit for State Street, one-third of managers said their operations and information technology needed to be improved, if they were to hit growth targets.

In fact, 21% said the state of their operations and technology could hamper their ability to achieve strategic goals over the next two years. Forty-two percent of said in-house systems were a challenge and 22 percent said their ability to capture and report regulatory data had to get better.

Which is where State Street thinks it comes in, with a set of services it believes it can put in place in six months or less for the typical "less complex" one-class or regional investment management firm.

State Street, at this point, intends to take in, process and store details on transactions for small- and mid-sized investment managers involving stocks, bonds, derivatives or whatever financial assets they deal in. State Street's outsourcing operation would handle all their post-trade activities, get information properly routed to counterparties, while confirming details with brokers and maintaining an investment book of record. Dividends, corporate actions and the like all get tracked, recorded and dealt with. Reference data maintained. Assets priced daily.

"We're taking our existing platform, the same exact platform we're using for the large guys, and what we're finding is for the smaller firms that it's just easier to connect them,'' said Taggart. "The integration time and energy and money is lower, because it's less complex. The inputs and the outputs and all that stuff that takes a lot of time for the large complex firms" takes a lot less time and effort for the less complex counterparts.

The practical result is that implementing service can be cut 75%, from two years for the big outfits to six months for the less complex ones.

"The challenges are always around integration,'' Taggart said. "You've got somewhat bespoke processes for trading and managing data and doing client reporting, and we need to work with a client to connect those processes to the standard platform we offer. Which means getting down and understanding data field by field, inputs and outputs, business logic. We've got a large team that's quite skilled at doing that,'' but it's easier and faster with a less complex business or organization.

State Street, quite often, comes to outsourcing the middle office needs of an investment manager through the back door: Custody. In its custody business, State Street handles $30 trillion of assets.

"Almost all of our clients started when they were a custody client, and then we moved into the middle office,'' Taggart said. "In some cases we're starting to move into the front office with data- and analytic-type services that some people would say are more front office-type services."

In the middle office, it is "all about getting the data flows aligned with regard to all the inputs related to transaction processing and reference data and account set up, and making sure that's all seamless,'' Taggart said. "It just takes time to get it well-defined and tested.''

That means roll-up-the-sleeves detail, on both sides. "This is not just us arriving and pulling this thing over the line,'' Taggart said. "We've got to have a client that's prepared to engage, because they've some work to do on their side."

Otherwise, State Street might as well let competitors like Bank of New York, Northern Trust and other large custody banks have the business-and the risk that the outcome won't be satisfactory to either side.

The bigger opportunity may still be with the big asset managers such as PIMCO. "But, now as we're approached by these less complex managers, we're able to say here's the standard, here's how it works, and we can find a way to give them the advantage of our scale with a lot less hassle,'' Taggart said. "Because the interfaces and the standards are all well-established. So it's just a way to service those clients which (often) are existing clients of the firm any way.''

In the 2012 Money Management Executive Operations Survey of fund managers, more than a third of respondents who worked for firms with $50 billion or less in assets expressed concern about their ability to match and reconcile trade details.

But only 9% indicated they would consider outsourcing the entire process.